Even with increased drilling activity and utilization, the 2Q 2011 growth in day rates was precisely the same as it was in 1Q 2011: 3%. That is far below the quarterly gains of 13% and 12% in first half 2010. That’s according to the latest issue of The Land Rig Newsletter’s Day Rate Report. The 600–750 hp group saw average day rates across all regions increase by 1.8% in Q2. Compare that with an average quarterly gain of 7.4% for first half 2010. In 2Q 2011, average day rates for the 1,000 hp class rose by 4.6% vs. a quarterly day rate hike of 13% in first half 2010. The difference is even more stunning with the 1,500 hp comparisons. These highly sought-after rigs in 2Q 2011 virtually duplicated their 1Q day rate increase of 3.5%, coming in at 3.4%. But this class saw a big jump in day rates a year ago with an average quarterly gain of 17.5% for first half 2010—including a wild 22% spike in Q1 2010.

The pace of growth in land rig day rates began to moderate in 1Q 2011. After averaging growth of 8.75% in 2010, the aggregated average U.S. land rig day rate across all regions and all horsepower classes rose only 3% in 1Q 2011, according to the latest issue of The Land Rig Newsletter’s Day Rate Report. Of course, signs of moderation in day rate increases cropped up in second half 2010, as respective jumps of 13% and 12% in Q1 and Q2 gave way to a 5% increase each in Q3 and Q4.

 

Another way to look at the slowdown in rate growth is from the perspective of the average day rate weighted to 600–750 hp rigs, which rose only 2%. The culprit? Declining growth in overall demand for rigs and gas-directed rigs in particular. But deceleration day rate growth to a quarterly increase of a 3%—or even 2%, for that matter—is hardly cause for panic, especially after rates in the first quarter of this year climbed to their highest level in more than two years.

The continuing surge in day rates confirms a drilling industry that has moved beyond recovery into a growth mode, according to the 2Q 2010 Day Rate Report. Rig rates calculated as a straight average for all rig classes in all regions across the U.S. posted a double-digit increase for the second consecutive quarter in 2Q 2010, at 12% nearly matching the 1Q 2010 gain of 11%.

 

It’s been a remarkable turnaround for a metric that was still trending slightly down as recently as 4Q 2009, finding bottom at yearend. The comparison changes markedly when comparing day rates weighted to the average horsepower of the U.S. land fleet, historically pegged at 600-750 hp. Using that methodology, the 2Q gain for the U.S. fleet was only 6% vs. a 10% jump in 1Q 2010.

 

But taking a closer look at the rate breakdown by rig class helps illustrate how the 600-750 hp class is “bringing down the curve.” The smaller rig class posted an increase of only 6% compared with a 13% jump for 1,500 hp rigs. 

Term contracts are making a comeback for drillers with high-spec rigs. Since the year started, the major drillers have seen operators increasingly use term contracts. As newbuilds roll off original contracts, the 3-year terms that undergirded their creation have been replaced with shorter-term contracts—from as little as 6 months up to 2 years. In an interesting twist, the industry continues to demand new equipment and is willing to support newbuilds with even longer—as much as 5-year—contracts.

 

Last fall drilling contractors reported that operators were buying out term contracts or delaying their drilling programs by idling newbuilds under tolling clauses. The added cash flow from early termination and tolling fees helped the contractors weather the lean times, and the tolling arrangements kept the rigs under the control of the operators who helped build the rigs.

 

There were concerns too many rigs would be pushed into the spot market and drive down day rates. But instead demand grew. Now major drillers see busy fleets, and some high-spec rig fleets are booked through the remainder of 2010. 

Times are tough for owners of small, mechanical rigs today. The 1Q 2010 issue of The Land Rig Newsletter’s Day Rate Report reported that fleet utilization of <500 hp rigs has languished below 50% for more than six months now. In fact, that group’s utilization rate has been above 60% only three times since October 2008. Consequently, some small drillers in conventional-gas-prone areas that are still working are doing so at cash operating costs.

The Day Rate Report also cited just one regional rig class in the U.S. that failed to recover in terms of rig rate appreciation from October 2009 to April 2010: Day rates for <500 hp rigs in the Midcontinent dropped again last quarter while rates were up everywhere else for every other type of rig.

These indicators suggest that the small drillers with the low-spec mechanical rigs will likely undertake most of the scrappage this year and be more likely to close their doors. 

According to 1Q 2010 surveys by The Land Rig Newsletter’s Day Rate Report, drillers are generally optimistic over market conditions in oil basins.  However, drillers reported that lower natural gas prices have begun to dampen prospects for more drilling in the near term, and many operators are pessimistic over the low gas price as well.  In any case, market conditions in the industry have improved since the same time last year when drillers in the 1Q 2009 survey reported prospects for work were very low for both oil and gas drilling.  At that time, there were no wait lists, no bid inquiries for future work, and work backlogs were at a standstill. In the current 1Q 2010 survey, however, market conditions are showing an improvement since the 4Q 2009 survey.  Observing the four surveys completed and published in the Day Rate Report over the last year, all indicators point to “bottom” in late 2Q 2009 or early 3Q 2009 and improvement in 4Q 2009.